China always believed in the US economy. As China over the decades, became better and better at making a name for itself in manufacturing, the country placed most of its income from selling to the US, in an investment that it considered very safe, just as anyone would, in government bonds in the U.S. The U.S though is under severe economic stress today and is not really in a position to make good on the two trillion in China's money that it owes that country for goods and services used. When China tries to use its money right in the US by trying to buy up American oil wells and mines, the only major areas in US investments it seems interested in, it faces insurmountable regulatory hurdles from Washington. As China's highest authorities express concern at this state of affairs, world stock markets react with apprehension and dampened confidence for the future. The world today is beginning to wake up to the possibility that all of the prosperity enjoyed by the world in the past few decades might have all been an illusion; the world might just have been pumped up on some kind of a pyramid scheme or Ponzi scheme. Schemes such as these inevitably collapse one day and take down the lives of all those connected to them.Was it all a Ponzi scheme? About a decade ago China was caught up in a very damaging monetary fiasco that severely hobbled its economy. In attempting to rebuild its financial infrastructure after this event, the government made it its policy that China's monetary unit needed to be tightly pegged to the US dollar. This policy worked to make Chinese currency and all Chinese products purchased with it, very affordable to the US businessman who was flush with dollar currency. Manufacturing houses in the US found that they could just close down their factories in the US, and manufacture everything in China for a fraction of the cost. This had a devastating effect on the ability of the US as the country to provide well-paying manufacturing jobs to its citizens. As hundreds of thousands of manufacturing jobs were lost, people simply moved to low-paying jobs wherever they could find them. This whole shift was held up and praised as a step in globalization.
What was China do with all the foreign reserves that had been built up selling stuff to the US? It could have returned the favor by buying up American-made cars, technology and other merchandise. China had other plans though: they did not want to weaken their economy by buying from outside. They decided to just set aside their money for another time: they invested it in US treasury bills. When fantastic quantities of government investment are bought up, it has the effect of lowering the receiving country’s interest rates. Low interest rates seen around the US at the time translated in to put cheap loans into people’s hands; families could afford to borrow to maintain classy and extravagant lifestyles even when they did not have enough money coming in. Americans kept the money flowing in by dubious financial strategies such as refinancing homes that they did not really own. Home values kept rising for no good reason, and this made Americans artificially well-heeled for some timel.
If you were to try to compare this way of running a country to the most famous Ponzi scheme ever, the one in the news all the time now with Bernie Madoff you would see disturbing similarities. In the investment-friendly environment of the 90’s and in the years that followed, the investment house of Bernie Madoff was able to see fantastic success in attracting new investments, new funds. When the company was flush with funds, Madoff was able to take care of immediate obligations and put out an image of a healthy enterprise. When easy investments from around the world dried up, there was no way for Madoff to keep up appearances anymore; the whole scheme collapsed when too many investors wanted to call in their investments and new influx stopped at the same time. Investors with Madoff who always received statements on their investments that said they were millionaires were suddenly left with empty and worthless investment accounts. But the Madoff system did not just disappear one day with all the money: the money disappeared the day it was brought in by the investors. The Ponzi millionaires were actually always broke, as there was no money to back up that Madoff's imaginary returns. But it was only when the whole thing collapsed that the individual investors actually learned about it.
The cheap credit brought in by cheap goods from China that floated the US over the past ten years merely provided an appearance of financial health, much the way Madoff's ability to pull in new investors kept his whole Ponzi show going. The moment that China stops being such a willing partner in US irresponsibility, the whole system will unravel the way a Ponzi scheme will the moment too many investors come in calling for their money at the same time. China could actually call it all off, after realizing that it was all a poor bet. But if it does that, it will suddenly have to face the fact that it has nothing to show for all the investments it has made. China will be in big trouble if it pulls the plug, and in bigger trouble if it doesn't. It could try to sell all of the treasury bonds it has on the open market, but selling a large quality of any investment brings down its market value very quickly. China wouldn’t want to devalue its own investments. China then, is truly caught between a rock and a hard place.
If they stop selling to the US in return for treasury bonds to at least make sure not to dig themselves in any deeper, they will drive up international interest rates, and that would devalue all their investments too. If they try to cash in investments they have bought already, they will quickly discover that they're sending the US government into bankruptcy; that will destabilize all the investments that they have ever made in their lives. These days, China places its faith in investing in raw materials over investing in the US dollar.
Global financial markets now are no longer about to put up with this. Most of the new value generated over the past decade has been blown on useless conspicuous consumption and not put back into the economy. This has destroyed the fabric of the American economy, ruined employment and ruined the housing market. If China were to un-peg their currency from the US dollar, that action would stabilize things; but that is not about to happen either. The only thing left for the US to do is either to tame its out-of-control spending habit, or to do away with issuing treasury bills in US currency in favor of treasury bills in Chinese money. Since none of these is a practical or acceptable solution, a slow and agonizing day-by-day repair of life is all there is left to do. Either way, it is uncertain that the US will ever regain its footing for a long time.
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